Look for more tax advice from Jeffrey Parker in our upcoming Law & Tax Resource Center.
If you had to file your taxes tomorrow, would you be ready? The answer for most business leaders would be, NO. Tax planning, although cumbersome, is critical to maximizing your bottom line. Since another tax deadline is right around the corner, there is no better time than NOW to strategize and plan for your 2004 returns. You should start thinking about how to maximize tax provisions created by The Jobs and Growth Tax Relief Reconciliation Act of 2003, American Jobs Creation Act of 2004 and Working Families Tax Relief of 2004, to lower your tax liability. Fortunately, there are a number of smart tax strategies to follow that may alleviate some of the stress that goes along with filing business taxes.
Organize Your Financial Records
It may sound simple, but business owners should always keep good records, be organized and understand what accounting teams need to prepare financial statements or tax returns. You can save your accountant a lot of time and significantly reduce accounting bills by providing your accountant with efficient documentation. If your accountant spends his or her time sorting through receipts or correcting your books, she may not have the time to discuss important issues such as ways to improve your business, reducing expenses, retirement planning or tax credits available to reduce your tax bill. Remember, accountants are really business consultants, and they should dedicate their time doing what they do best--advising you on how to improve your business and reduce your tax bill.
Like individuals, businesses can save on taxes by timing income so that it is received in the year it will be taxed at the lowest rate. Your accounting method determines when you must recognize income and deduct expenses. For example, under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year.
If you are an accrual method taxpayer, you have a little more freedom to accelerate deductions. For instance, your business may be able to deduct:
- Employee bonuses, which are deductible even if your company will not pay the bonuses until early 2005. Make sure the corporation declares the bonuses before year-end and pays them within the first 2 and a half months of 2005. Bonuses generally cannot be accrued for employees who own a greater-than-50% interest in the business, if it is a C corporation. Bonuses cannot be accrued for S corporation shareholders who own more than 2 % of the stock. In addition, partners or members of partnerships and LLCs cannot accrue bonuses no matter how little stock they own.
- Charitable contributions you have planned for early 2005 if you note the charitable obligation in the corporate minutes before the end of your 2004 tax year. You must make the contribution within the first 2 and a half months of 2005.
- A profit-sharing plan or 401(K) contribution, even if your business will not have the cash to contribute until after the end of the year. You have until the due date of your return to contribute, a possible 8 and a half months after year-end if your corporation receives a valid six-month filing extension. Consider this approach even if you do have the funds available at year-end so that your business can invest the cash or use it for business purposes until the contribution is due.
Cash-basis taxpayers report income items, when actually or constructively received, and deduct expenses when payments are actually disbursed. Small-business owners who operate on a cash-basis typically are urged to accelerate expenses and defer income near the end of the year in order to minimize tax liability. For tax years beginning in 2003 and now extended through 2007 (from 2005) by the American Jobs Creation Act of 2004, small business owners can elect to immediately deduct 100% of the cost of qualified business property placed in service before 2008 up to $102,000, instead of depreciating it over several years.
For instance, you can deduct the cost of new computer systems, off-the-shelf computer software, furniture, fixtures, manufacturing equipment and the like. Keep in mind that this "Section 179" allowance is phased out on a dollar-for-dollar basis when qualifying assets costing over $410,000 are placed in service before 2008. Also new for 2004, taxpayers can revoke these write-offs on amended returns without IRS consent through 2008. In addition, if the business has a loss in the current year, the 179 deduction is disallowed and carried forward to the next year. The maximum amount that businesses can write-off under Section 179 is scheduled to drop dramatically in 2008, so plan your asset purchases accordingly.
If you anticipate a substantial increase in business income next year, with a corresponding higher tax rate, speak with a CPA about postponing expenses until 2005 which might be more tax effective than accelerating expenses into 2004.
Utilizing Depreciation Tax Breaks
The ability to recover some of the costs of newly acquired business assets over time through depreciation is an important tax benefit for businesses. When you purchase assets and how you choose to depreciate them can make a difference in your tax bill. This is the last year that your business can claim a special first-year depreciation "bonus" equal to 50% of the cost, or other adjusted basis, of qualified business property purchased and placed in service in 2004. This allowance is in addition to a modified regular deduction for first-year depreciation. It is available for both regular and alternative minimum tax purposes and is subtracted from the property's cost basis before the regular first-year depreciation is computed. It can also be coordinated with the expensing election under Section 179.
SUV Tax Break--Catch it While You Can
Small business owners who are thinking of purchasing large sport utility vehicles or full-size pickup trucks should consider taking advantage of a tax loophole that will close soon. Small business owners that qualify are those who have purchased vehicles in 2004 weighing more than 6,000 pounds (fully loaded) and driven for 100% qualified business use. This includes trucks such as the Ford-150, Dodge Ram and similar vehicles, typically popular with construction companies, landscapers, farmers and delivery services.
This tax break is also open to professionals such as lawyers, doctors and sales executives etc., who drive a Hummer, BMW X5, Cadillac SRX or similar luxury sports utility vehicle in the weight class, for 100% business use. This loophole allows a write-off against taxes up to $102,000 from purchases of these vehicles, which usually turns out to be the entire price of the vehicle. This tax break will end this year, due to recent tax limitations outlined in the American Jobs Creation Act of 2004. If you wait until the act is signed by the President before the end of 2004, you will only be allowed to write off the first $25,000 of the cost of a sports utility vehicle 14,000 pounds or less (fully loaded.) However, bonus depreciation will still be available for purchases made through the remainder of 2004. So if you need a large sports utility vehicle for your business, consider purchasing one before the end of 2004. When deciding on a sports utility vehicle, be sure to verify the weight of the vehicle with the dealer.
Pre-Pay Your Bills and Defer Income
Cash-basis taxpayers may want to prepay as many bills as possible by December 31, 2004. Do not wait until January 2, 2005, to pay your bills or you won't be able to claim those expenses until 2005. You also have the option of deferring income. Consider notifying your clients in December that, as a holiday benefit, you are extending their credit terms from 30 days to 60 days. This is a way to show appreciation for your customers and reduce deposits in December.
Make Charitable Donations
Making donations by the end of this calendar year is very smart tax planning. Donate items such as unused office equipment or cars to charitable entities by December 31 and claim them as donations for 2004. The current law allows donors to deduct fair market value for most items including cars. Beginning with tax year 2005, if a car is donated to a charity and sold, the donor will only be allowed to deduct the gross proceeds from the sale of the car, as well as, provide significant documentation about the transaction.
Now is a very good time to review inventory and get rid of merchandise or equipment that is obsolete, not selling, or damaged. Instead of letting it sit around, hoping it will sell eventually and letting it cost you money to keep it, get rid of it now. Keep track of what you do with bad inventory, because it may be deductible as a business loss or a charitable donation. Consult with an accountant about what you intend to donate as some donations may require paying a "use tax" on donated merchandise, particularly if you bought it using a resale certificate.
Establish a Pension Plan
The government is making it attractive to contribute to or set up a new pension plan for your company. Small employers (100 employees or less) can receive a tax credit for establishing a pension plan for the company for up to 50% of the cost of setting up the plan. The credit is limited to $500 in any tax year, but can be claimed for qualified costs incurred in the year the plan is established as well as plan startup costs incurred in each of the following two years.
Deduct Self-Employment Expenses
If you are self-employed, here are some additional tips:
- You can deduct 100% of amounts paid for health insurance for yourself, your spouse and your dependents as a business expense, while requirements apply.
- You also can deduct half of your self-employment tax. In 2004, the 12.4% OASDI (Social Security) part of the tax applies to self-employment earnings of up to $87,900. The 2.9% Medicare tax applies to all your self-employment income.
Business tax laws can be challenging. Be sure to speak with a CPA or other financial professional about which tax strategies will best benefit your company. As a rule of thumb, you should always be cognizant of your finances and the tax credits available to you. Take the time you have now to plan for later. For more information on tax laws that may impact your company, visit www.irs.gov/smallbiz .
Sidebar: Section 179 Deduction Best Practices
If you know that you are going to need $102,000 worth of equipment reasonably soon, but you have only purchased $20,000 so far, buy the rest of it before the end of the year so you can take the full expense deduction in the 2004 tax year. Or, you might want to delay some purchases if you are already at $102,000 and save them for 2005, so you can get the full deduction next year. You cannot deduct so much that it puts your company into an overall loss for the year, but you can try to zero out your profits or reduce them, and thus reduce your tax liability. You can receive the expense deduction on purchases you make up to December 31, 2004. Even if you charge the equipment on a credit card or buy it with the proceeds of a loan, as long as you are on a cash-basis accounting system, it's still deductible. And you can also deduct credit-card interest you are paying related to business purchases.
ABOUT THE AUTHOR
Jeff Parker is a principal with Rothstein Kass-Certified Public Accountants (www.rkco.com), one of the top 20 largest international accounting and consulting firms based in the U.S. He is a certified public accountant and attorney in New Jersey. Jeff advises closely-held entrepreneurial companies on business finance issues and taxation; in addition to, providing tax services for real estate companies, broker-dealers and high net worth clientele for the Firm's financial and entrepreneurial services practices. Jeff also assists clients with estate and gift tax matters.
Jeff helps manage the Firm's tax department and oversees tax processing procedures in the New Jersey office. He works with a number of real estate development and rental entities on several engagements including handling tax free exchanges. In addition, he manages compliance and planning matters for several clients in the manufacturing and professional service industries, including reviewing attorney trust accounts for law firms to ensure compliance with the applicable statutes.
Jeff is a member of the American Institute of Certified Public Accountants (AICPA), the New Jersey Society of Certified Public Accountants (NJSCPA), the American Bar Association (ABA), the New Jersey State Bar Association (NJSBA) and the National Organization of Office and Industrial Properties (NAIOP.)
Rothstein Kass is ranked among the top 20 largest accounting firms in the nation according to Public Accounting Report's Annual Top 100 of America's Largest Public Accounting Firms and among the top 10 accounting firms in the New York Area, according to Crain's New York Business. Rothstein Kass is headquartered in Roseland, New Jersey with offices located in New York, Beverly Hills, San Francisco, Walnut Creek (CA), Dallas, Denver and an offshore office in the Cayman Islands. For information, visit www.rkco.com.